Vacancy Rising In Phoenix Despite Construction Pullback

Though employment growth will stimulate an increase in retail sales in 2010, the job additions will not be sufficient to prevent the vacancy rate in Phoenix from rising for the fifth consecutive year, according to the latest Retail Research market update from Marcus & Millichap.

Unlike previous years when excessive construction drove vacancy increases, lagging demand has become the anchor on the market. The pace of store closures clearly has slowed, but too few retailers have emerged to open new locations in the vacant space that has amassed. With the vacancy rate nearing its highest level in 20 years, rents continue to fall as tenants exercise the upper hand in discussions with owners.

Rents have yet to settle at a new, lower market level and may not reach their low point until late next year. The upside of reduced rents, however, has been a sharp decline in construction, as many projects simply no longer pencil for developers. After deliveries averaged 5.5 million square feet of new space each year during the past decade, a fraction of that total will come online in 2010.

Although the slowdown in construction represents a positive trend in a market with frequent overbuilding spells, the lack of properties under construction will restrain sales of new single-tenant, net-leased assets. As in other markets around the country, single-tenant properties net-leased to top-rated corporate tenants generate intense bidding when listed. In fact, cap rates for nationally branded drugstores and fast-food properties have fallen about 50 basis points since early this year to around 7 percent, with ground leases commanding even lower first-year returns.

In the multi-tenant segment, buyers have intensified searches for suitable listings, but the ongoing reduction in rents continues to present challenges to arriving at valuations upon which owners and prospective buyers can agree. Current underwriting assumes additional increases in vacancy and further rent reductions, such that cap rates must vary from 10 percent to 11 percent to generate bids. Among specific properties, those with tenants that signed leases at the peak of the market
in 2006 and 2007 invariably face the prospect of re-leasing space at substantially lower rents when leases expire.

2010 Annual Retail Forecast

Employment: Government employment will decline over the second half due to the termination of census jobs and budget constraints at the state and local levels, while private
sector employers will hire conservatively. As a result, total employment will expand 0.8 percent in 2010, or by 13,700 jobs. Last year, 116,000 positions were cut.Construction: Developers will complete 500,000 square feet of space this year, the lowest annual total in 30 years. In 2009, approximately 2.9 million square feet came online. Planned projects total 28 million square feet, although none has a scheduled start date.Vacancy: The vacancy rate will increase 70 basis points this year to 12.6 percent, as store closures and a lack of new demand will result in negative net absorption of 721,000 square feet. Vacancy spiked 260 basis points last year and most recently surpassed 12 percent, a level last reached in 1991.Rents: This year, asking rents will decrease 1.3 percent to $18.11 per square foot, following a 5.5 percent dip in 2009. Effective rents will slide 2.6 percent to $15.13 per square foot, compared with a 9.1 percent drop last year.

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